I’m Not Dead Yet
Q1 2016 was a great quarter for bond investors. It served as a reminder that there is still life in the bond market and there are benefits to a diversified portfolio. Domestic bond returns of 3.30% as measured by the Barclays Aggregate Index were the strongest since Q3 of 2011 when the benchmark returned 3.82%. However, these returns were dwarfed by the performance of bond markets around the globe including Europe where the yields on a large portion of sovereign debt is in negative territory. The table below lists the Q1 returns and current yields of some of the key sectors of the debt markets:
|Asset Class||Q1 2016 Return||Current Yield|
|Emerging Market Sovereign Bonds||11.02%||6.51%|
|Global Aggregate Index||8.26%||0.74%|
|EU Govt. Bonds||7.24%||0.62%|
|US Municipal Bonds||1.67%||1.93%|
|Investment Grade Corporates||3.97%||3.21%|
|US Aggregate Index||3.30%||2.16%|
Two key factors contributing to the quarterly performance was another round of “Quantitative Easing” by the European Central Bank (ECB) and the rally in oil prices which helped relieve pressure on credit spreads in both high yield and investment grade corporates. It is often the case when bond returns have a period of very strong performance it is followed by a period of weaker or even negative returns. The primary reason for this is the fact that the decline in yields which produced the outsized returns is usually followed by a period of consolidation or even rising interest rates. The strong returns in EU Government bonds despite near zero – and in some cases – negative rates should serve as a reminder to investors that there are two components to bond returns; the income component and the price component.
With interest rates in the US and abroad at or near multi decade lows, bond investors should be realistic about future bond returns. However, an allocation to fixed income continues to provide significant benefits to diversified investment portfolios. At Yellowstone Partners we continue to believe that below average economic growth and benign inflation in the developed economies means that interest rates will remain “low” in those economies for some time. That said, the steady income and low volatility of a diversified bond portfolio will continue to provide the same benefits to investors that they have in the past and investors who continue to hold fixed income securities as part of a diversified portfolio will be rewarded.